Climate Change 2001:
Working Group III: Mitigation
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1.2 Cost-effective Mitigation

1.2.1 Introduction

This section describes the key themes that have been pursued by the research community working from the “cost-effective mitigation” perspective (as conceptualized in Figure 1.2). The focus here is on the kinds of issues that the research community working from this perspective address and not on specific results.

Figure 1.2: The cost-effectiveness perspective.

Researchers working from a cost-effective perspective generally focus on achieving some policy objective at minimum cost. Cost minimization, in some cases, is used to compare alternative ways to meet some climate policy objective (like a specific GHG emissions or concentration target); in other cases, alternative ways to minimize the total cost of climate change and policies designed to ameliorate its impacts are considered. In the former, the policy objective is included as a constraint; but in the latter, the objective is to minimize the cost of the climate change. In either case, the policies considered are generally restricted to those that directly affect energy use or other activities with a direct impact on GHG emissions. Although equity and sustainability metrics are frequently examined in these analyses, their inclusion usually occurs after the cost-effectiveness calculations have been completed. Exceptions to this general observation include input assumptions related to discounting and utility function parameters that do represent trade-offs between the utilities of various groups and generations. Judicious use of sensitivity analysis can, however, illuminate the trade-offs implied along these dimensions, but these trade-offs are not usually the main focus of such studies. It is therefore difficult, ex post, to graft other policy objectives related to development or sustainability (e.g., poverty reduction, human capital development) onto a cost-effectiveness style of assessment.

1.2.2 The Costs of Climate Change Mitigation

The United Nations Framework Convention on Climate Change makes clear that cost-effectiveness is an important criterion to be used (among others) in formulating and implementing climate policies. As stated in Article 3.3 of the convention “…taking into account that policies and measures to deal with climate change should be cost-effective so as to ensure that global benefits at the lowest possible cost (UNFCC, 1992)”. The impacts of climate policy can be defined as the changes that policies cause relative to some “business-as-usual” or “baseline” situation. As discussed in Chapter 2, a baseline is a scenario of how the global or regional environments, depending on the study, will evolve over time (often over 100 years or more for baselines used in climate policy studies) in the absence of climate policy intervention. Thus, a baseline is typically built upon assumptions about future population growth, economic output, and resource and technology availability, as well as upon assumptions about future non-climate environmental policies, like controls on sulphur dioxide emissions. Changes from these baselines are frequently put into categories of “benefits” and “costs”. The benefits included in the calculus are estimated from avoided climate damages and other ancillary benefits that would have otherwise occurred if mitigation policies had not been introduced. The costs for mitigation and other side effects that result are estimated from economic sacrifices that might be required to mitigate climate change.

Climate change would be a relatively simple problem to overcome if it could be avoided without sacrifice and if the means to effect this avoidance were recognized widely. At present, however, there are concerns about the sacrifices that avoiding climate change might involve. A fundamental challenge in mitigation policy analysis is thus to discern how climate change can be avoided at a minimal cost or sacrifice. Chapters 3-9 describe a number of advances since WGIII SAR that identify methods to reduce the costs of climate change mitigation. Indeed, these chapters report that some degree of mitigation might be achieved at zero cost.

Chapter 7 distinguishes several cost concepts. Opportunity cost (the value of a sacrificed opportunity) constitutes a basis upon which estimates of economic cost are constructed. The extent of the costs of mitigating climate change is, from an economic perspective, measured in terms of the value of other opportunities that must be forgone (for example, the opportunity to enjoy low prices for domestic heating or other energy services). It follows that economic costs can be different when they are viewed from different perspectives. Costs of mitigation incurred by a regulated sector are, for example, generally different from economy-wide costs. Costs are sometimes measured in currency units, but they are sometimes also measured against other metrics. In all cases, though, the underlying element of cost is the sacrifice of opportunities, goods, or services; and this element is often quite different from the overt financial outlay involved.

Chapter 7 also indicates that some notions of cost incorporate behavioural, institutional, or cultural responses that can be missed by economic analyses. In measuring opportunity costs, more specifically, economic analyses generally take personal preferences, social and legal institutions, and cultural values as given. Yet climate policies can affect (positively or negatively) the functioning of institutions. They can alter the ways in which people relate to each other; and they can influence individuals’ attitudes, values, or preferences. Taking these impacts into account can alter the cost assessment. Moreover, while economic analyses (including standard benefit–cost analyses) tend to measure costs by adding up individuals’ valuations of their forgone opportunities, other approaches to cost can be defined in terms that are not simple aggregations of individual measures.

As discussed below, equitable policy making brings attention to the distribution of costs as well as to their aggregate levels. There has been considerable progress since SAR in identifying ways that climate change can be avoided at lower costs. Both theoretical and modelling studies have helped to reveal the types of policies that might achieve given targets at the lowest cost. Moreover, as indicated below, models have identified certain circumstances in which at least some reductions in GHGs might be achieved at no cost.

Chapter 8 reports that the cost of mitigation can depend significantly on the selection of a designated concentration target that, typically, is assumed to be achievable within 100 or 200 years. Most model-based studies indicate that the first units of abatement are fairly inexpensive; “low-hanging fruit” is easily picked. However, most studies show that additional units of abatement require more extensive changes and involve significantly higher costs.3 Thus, to lower the original concentration target is projected to result in a more than proportional increase in costs. Rising marginal abatement costs provide a rationale to employ broad-based, economically efficient mechanisms for GHG abatement.

The cost of mitigation depends not only upon the cumulative emissions reductions required over the next century, but on the timing of these emissions reductions as well. Chapter 8 reviews some studies that argue the most cost-effective approach to achieving a given long-term concentration target involves gradually rising abatement through time. The attraction of this approach is that it helps avoid the premature turnover of stocks of capital. In addition, deferring the bulk of abatement effort to the future allows more discounting of abatement costs. However, other studies show potential cost advantages in concentrating more abatement towards the near term. These studies argue, in particular, that near-term abatement helps generate cost-effective “learning-by-doing”, by accelerating the development of new technologies that can reduce future abatement costs. These findings are not necessarily contradictory. By introducing mitigation efforts in the near term, the process of learning-by-doing is initiated. At the same time, by increasing over time the stringency of policies (that is, the extent of abatement), nations can avoid premature capital-stock turnover and exploit the cost savings from future technological advances. Chapter 10 elaborates on these issues.

It is worth emphasizing that abatement policies (such as the introduction of national targets on carbon emissions or policies to stimulate the development of energy technologies not based on carbon, as discussed in Chapter 3) can proceed in the near term even when abatement efforts are significantly deferred to the future. The near-term introduction of policies helps to stimulate efforts to bring about new technologies, which is crucial to enable future abatement to be achieved at lower cost.

As Chapter 6 discusses, individual countries can choose from a large set of possible policy instruments to limit domestic GHG emissions. These include traditional regulatory mechanisms such as technology mandates and performance standards. They also include “market-based” instruments such as carbon taxes, energy taxes, tradable emissions permits, and subsidies to clean technologies. They also include various voluntary agreements between industries and regulators. A group of countries that wishes to limit its collective GHG emissions can agree to implement some of these policies in a co-ordinated fashion.

Chapters 6-9 reveal that the costs of achieving specified mitigation targets depend critically upon the policy instrument employed. Any given target is achieved at the lowest cost when the incremental cost of emissions reduction (abatement) is the same across all emitters. If this condition is not met, then the overall costs of emissions reduction could be reduced if firms with lower incremental costs reduced emissions a bit more, and firms with higher incremental costs pursued a bit less abatement. It follows that cost-effective emissions reductions hold the promise of allowing larger emissions reductions from any allocation of resources

While market-based instruments such as carbon taxes and tradable carbon permits have potential cost advantages, the extent to which these potential advantages are actually realized depends on whether the policy generates revenues and whether these revenues are “recycled” in the form of cuts in existing taxes. Revenue recycling is important to the costs of a carbon tax, for example. When the revenues from the carbon tax finance reductions in the rates of pre-existing taxes, some of the distortionary cost of these prior taxes can be avoided; and so the cost of mitigation is reduced. These issues are further elaborated in Chapters 6-9.

The issue of revenue recycling applies also to policies that would reduce CO2 through carbon permits or “caps”. As discussed in Chapter 6, revenues could be recycled through cuts in existing taxes if CO2 permits are auctioned. In contrast, if the permits are distributed freely, then no revenue is collected and there is no possibility of revenue recycling. Thus, auctioning the permits has a significant potential cost advantage over free allocation.

It is also important to keep in mind that aggregate costs are not the only useful consideration in evaluating alternative policy instruments from the cost-effectiveness perspective. The distribution of these costs across businesses, regions, and individuals is important as well. Moreover, other important evaluation criteria, including administrative and political feasibility, can play a role in determining exactly how and why mitigation initiatives might emerge.

The theoretical and modelling literature also reveals that international policy co-ordination through “flexibility mechanisms” offers enormous opportunities to achieve given reductions in GHG emissions at relatively lower cost. In principle, co-ordinated policies can be designed so that cost-effectiveness is improved on a global scale. The Kyoto Protocol defines several flexibility mechanisms, including international emissions trading (IET), joint implementation (JI), and the clean development mechanism (CDM). Each of these international policy instruments provides opportunities, in theory, for Annex I Parties to fulfil their commitments cost-effectively. IET allows Annex I parties to exchange parts of their assigned amount. Similarly, JI allows Annex I parties to exchange “emission reduction units” among themselves on a project-by-project basis. Under the CDM, Annex I parties receive credit, on a project-by-project basis, for reductions accomplished in non-Annex I countries. Participation in these programmes can also increase the level of investment in clean energy technologies. International policy co-ordination in implementing climate policy also requires accounting for the “ spillover” effects of mitigation in one country that can effect economic activity in other countries through international trade linkages. In general, countries that mitigate less may gain an advantage in their share of international trade over their trading partners, but can also lose market share if those trading partners control more and thus reduce their overall level of economic activity. See Chapter 8 for more on these issues.

Most studies of national or global mitigation costs focus on CO2 from fossil energy alone (e.g., see Chapter 8), but some recent studies consider other GHGs as well. For example, Chapters 3 and 4 discuss options to reduce emissions of non-CO2 gases and CO2 net emissions from land-use change, respectively. Chapter 8 indicates that defining national targets in terms of a “basket” of gases (as under the Kyoto Protocol) rather than in terms of individual gases enhances flexibility and can reduce the costs of mitigating climate change. Emissions of several of the GHGs (such as methane and nitrous oxide) from some sources can, in addition, be very difficult to monitor. This practical complication raises the potential cost of mitigation over the short- to medium-term, because it highlights the need to improve the methods used to monitor these emissions.

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